A Roth individual retirement account (IRA) is a personal savings plan that offers certain tax benefits to encourage retirement savings. Contributions to a Roth IRA are never tax deductible on your federal income tax return, which means that you can contribute only after-tax dollars. But amounts contributed to the Roth IRA grow tax deferred and, if certain conditions are met, distributions (including both contributions and investment earnings) will be completely tax free at the federal level.
A Roth IRA, like a traditional IRA, is not an investment, but a tax-advantaged vehicle in which you can hold some of your investments.
How much can I contribute to a Roth IRA?
To contribute to an IRA (Roth or traditional), you must receive taxable compensation during the year. For purposes of IRA contributions, taxable compensation includes wages, salaries, commissions, self-employment income, and taxable alimony or separate maintenance. Other taxable income, such as interest earnings, dividends, rental income, pension and annuity income, and deferred compensation, does not qualify as taxable compensation for this purpose. Your contribution for a given year cannot exceed your taxable compensation for that year.
If you file your federal income tax return as single or head of household and your MAGI for 2022 is $129,000 or less, you can make a full contribution to your Roth IRA. Similarly, if you file your return as married filing jointly or qualifying widow(er) and your MAGI for 2022 is $204,000 or less, you can make a full contribution. Otherwise, your allowable annual Roth IRA contribution is reduced or eliminated.
Are Roth IRA contributions tax-deductible?
Unlike deductible contributions to a traditional IRA, you do not have the option of deducting Roth IRA contributions and reducing your taxable income on your federal income tax return. You can contribute only after-tax dollars to a Roth IRA.
Are Roth IRA distributions taxable?
A withdrawal from a Roth IRA (including both your contributions and investment earnings) is completely tax free (and penalty free) if (1) made at least five years after you first establish any Roth IRA, and (2) one of the following also applies:
- You have reached age 59½ by the time of the withdrawal
- The withdrawal is made due to qualifying disability
- The withdrawal is made for first-time homebuyer expenses ($10,000 lifetime limit)
- The withdrawal is made by your beneficiary or estate after your death
Withdrawals that meet these conditions are referred to as qualified distributions. If the above conditions aren’t met, any portion of a withdrawal that represents investment earnings will be subject to federal income tax and may also be subject to a 10% premature distribution tax if you are under age 59½ (unless an exception applies).
Can other accounts be rolled into a Roth IRA?
Funds can be rolled over or converted from a traditional IRA, from another Roth IRA, from a Roth 401(k), 403(b), or 457(b) plan, or from a non-Roth 401(k), 403(b), or 457(b) plan.
Caution: These rules generally apply to IRA owners during their lifetimes. Special rules apply to spouse and nonspouse beneficiaries.
Funds in one Roth IRA can be rolled over tax free to another Roth IRA. This can be done as a direct transfer of funds from one Roth IRA trustee or custodian to another, or you can have the funds distributed to you and then roll them over to the new Roth IRA trustee or custodian yourself. If you choose the latter method and fail to complete the rollover within 60 days (from the date you received the funds), you may be subject to tax and penalty on the investment earnings portion of the funds (unless you qualify for tax-free withdrawals from the Roth IRA).
Caution: You can make only one tax-free, 60-day, rollover from one IRA to another IRA in any one-year period no matter how many IRAs (traditional, Roth, SEP, and SIMPLE) you own. This does not apply to direct (trustee-to-trustee) transfers, or Roth IRA conversions.
Roth IRAs can be a great tax-savings vehicle but come with complexities and nuances that should be carefully reviewed each year based on your specific circumstances.
